From those to whom much has been given, from them much shall be expected.
-- Luke

Wednesday, March 26, 2014

After QE; Piketty and neo-feudalism

There is a lot of nonsense going around about interest rates going up post-QE. Following John Hussman's lead, in a recent post I showed the empirical regularity governing the relationship between central bank balance sheet as a percent of GDP and long-term interest rates proxied by the 10 year T-bond.

Recently Base/GDP has been about 0.22, so we are way out on the right end tail. It would take a reduction of the ratio of about 15 percent of GDP to begin to raise long rates, or about $2.6 trillion at current rates of GDP. The St. Louis base is currently at $3.7 trillion, and has been growing at over 20 percent a year since the last recession.

Now, "tapering" is a reduction in the rate of increase of additions to the base, not a reduction of the base. The chart looks to me like a very strong empirical regularity indeed. So the chance that long rates will rise anytime soon is remote in the extreme, as the Fed has no announced plans whatsoever to actually reduce the base.
Long rates will remain low and the bad debt clogging the banking system will remain impacted, that much seems assured for years to come.
What is a somewhat lower probability outcome is that the dump-the-dollar movement internationally gains sufficient momentum that the Fed has to buy up more and more (perhaps virtually all) new Government debt. This might be called the MMT-by-force-majeure outcome, as there is little chance that such additions to the Fed's balance sheet will ever go away.

In this latter case rates will not go up because of the empirical regularity shown above, but as the dollar falls on the foreign exchange markets due to weak demand to hold or trade in dollars, there will be import inflation domestically in the US. This will cause a further collapse of effective demand--already afflicting the bottom 80 percent or so of Americans--as real purchasing power of consumers is decimated. The US will become an even less attractive place to invest, and capital flight will occur. The US's status as a banana republic will be cemented.

This is the essence of the dreaded global currency reset: the dollar falls on international markets, import inflation slams domestic real demand, but neither short-term nor long-term interest rates rise (short rates exhibit a similar empirical regularity to that shown above). A domestic stagflation occurs. The Fed, ever the servant of Capital, will fight the inflation with modest rises in short rates (this can be done administratively in the short run) sufficient to beat any thought of asking for higher wages out of the heads of workers even though labor cost-push inflation exists only as a curiosity in economic history textbooks.
In the final chapter plutocrats of various "nationalities" (with allegiance to none) will divvy up Plantation America, keeping the best parts of it private, for themselves and their would-be-royal progeny.Enter the Anti-Mainstream Economist

Certainly Thomas Piketty is the most important economist of the past 80 years, since the last Fourth Turning (Keynes got it that time). I highly recommend The New Yorker's review of his big book (here). A Frenchman, Picketty came to the US at 22 as a young economics superstar and to his great credit, became immediately disenchanted (disgusted is a better word, probably) with the status-quo-supporting mathematical fictions he encountered at MIT. (Disgust afflicted your correspondent upon entering economics at the graduate level in search of "science" after an undergraduate career studying literature.) Son of a leftist French couple, Piketty imbibed the Marxist notion of capital increasingly displacing labor leading to the reserve army of the unemployed and set out to study the issue of the distribution empirically, probably sensing that only real world data could displace the mathematical fictions of the self-congratulating, narcissistic mathematical economist-priests ruling policy in the West.

Piketty's concerns over where the world is going are as dire as mine. He is the Anti-Mainstream economist on the white horse that I thought could never possibly arrive. TheNew Yorker disappointingly pooh-poohs Piketty's suggestions that we need to raise taxes on the incomes and wealth of the plutocrats as politically infeasible. (But of course The New Yorker’s readership inhabits the status quo, so what else could they say?)
Democracy will have to be reborn to prevent a return to out-and-out feudalism.
It couldn't happen here, of course (although Piketty now has a stateside ally in fellow French-born Berkeley economist Emanuel Saez). Piketty turned tail after a couple of years in the US and returned to Paris, where he has remained since.